What is the Secondary Market? How it works

April 26th, 2023
3 minutes read

The secondary market is a financial marketplace where investors trade previously issued assets and securities such as stocks, bonds, and mutual funds. The most commonly known secondary market is the stock market, which includes national exchanges like the New York Stock Exchange (NYSE). Secondary markets also exist in the investment crowdfunding sector, allowing investors to buy and sell stocks of startups pre-IPO, and loans after the repayment period has started. This guide delves into secondary markets and their importance in the financial world.

How The Secondary Market Works

The key characteristic of a secondary market is that investors exchange securities with each other rather than with the issuer. Secondary markets drive securities prices toward their actual value through countless interconnected trades. They provide investors with the option of buying or selling a financial asset to someone other than the issuer. This liquidity is crucial to a well-functioning economy, as the issuer of the asset might not have the funds or the desire to trade whenever an owner of the asset places an order to buy or sell.

The secondary market refers to transactions that are one step away from the original transaction that created the financial asset in question. While secondary markets provide liquidity in the financial markets, investors can also gain access to various investment assets including stocks, and bonds, to broaden their investment portfolio.

Key Features of Secondary Markets

  • Investors exchange financial assets with each other rather than with the issuer.
  • Secondary markets drive financial assets toward their actual value through interconnected trades.
  • Transactions on secondary markets are one step away from the original transaction that created the asset.

Primary Markets vs. Secondary Markets

There is a crucial difference between the primary market and the secondary market. Primary markets involve the first-time issuance of securities, such as stocks or bonds, by companies that sell them directly to investors. Initial public offerings (IPOs) are a prominent example of primary market transactions. In contrast, secondary markets involve transactions between investors after securities are issued. Secondary market gains or losses belong to the selling investor, not the issuing company or underwriting bank.

Secondary Market Pricing Dynamics

While primary market prices are often predetermined, secondary market prices are influenced by supply and demand. Stock prices in secondary markets fluctuate based on investor sentiment and company performance. An increase in demand for a stock typically leads to a rise in its price, while a decrease in demand results in a decline.

On large national exchanges, liquidity and the number of investors buying and selling can reach very high levels of activity. However, on smaller more private secondary markets such as investment crowdfunding platforms, activity levels can be lower and that impacts pricing. If an investor needs to sell, but the number of readily investable amounts and investors active on the secondary market is scarce, the buyer might get a significant discount on what could be perceived as actual value.

This is due to insufficient buyer access and is often called 'low liquidity' on the stock market.[1] In simple terms, the asset is difficult to trade. An example of this is the Danish company Lendino trading on the secondary market of Funderbeam. Here Lendino's pre-IPO stocks were trading in small portions at €6.38 while the company raised €60,500 at €13.7 per share.[2]

Secondary Markets in Investment Crowdfunding

In investment crowdfunding, secondary markets enable investors to buy and sell loans or pre-IPO stocks that have already been funded. As a result, investors can exit loans and stocks of private corporations early and earn higher returns when buying at a discount. It is only a portion of the crowdfunding platforms that offer a secondary market.[3] Alternatively, some peer-to-peer lending platforms offer a buyback option to purchase loans at a discount rate or at par value, allowing investors to exit early.

Fees in investment crowdfunding secondary markets vary across platforms but are typically higher than national stock exchanges. They can range from 0.25% to 1% or more. It is essential to consider trading frequency and early exit requirements to evaluate the utility of a secondary market on an investment crowdfunding platform.

Article Sources

  1. U.S. Securities and Exchange Commission: “Liquidity (or Marketability)
  2. Funderbeam Lendino Syndicate: “Why indicate if aftermarket is cheaper?
  3. P2PMarketData Platform Search: “Investment Crowdfunding Platforms with Secondary Market